Yieldcos are publicly traded entities with a funny name and a focus on renewable energy that have delivered not-so-funny results for investors during the sector’s stunning downturn since midyear 2015.
These entities are holding companies created by power-generation concerns to operate renewable energy assets such as solar and wind power (although some operate conventional energy projects). Typically, the parent company owns a majority stake in the yieldco and spins off the rest in an initial public offering. There are about 20 yieldcos that trade in North America and Europe, with roughly half being U.S.-listed. Most yieldcos have gone public since 2013.
For the parent company, or sponsor, spinning out a holding company to buy and operate energy assets provides capital to develop future projects at a cheaper cost than the company could with tax equity finance. Yieldcos, short for “yield companies,” buy power projects from their parent company through “drop-down” transactions. These projects have long-term agreements to deliver electric power to customers, and they generate steady cash flows.
Because yieldcos can take advantage of tax benefits such as MACRS (modified accelerated cost recovery system) depreciation, as well as investment tax and production tax credits, they can offset gains and not generate taxable income for many years. In general, anywhere from 70% to 90% of the cash accrued by yieldcos is paid out to shareholders at—in most cases—significantly higher levels than yields offered by dividend stocks or bonds.
On paper, it sounds like a winning formula that addresses two powerful themes in today’s investment zeitgeist: the yearning for income in a low interest rate environment and the rising demand for “green” investing in areas such as clean energy. Initially, investors ate up the platter of yieldco IPOs dished out in recent years. Of late, they’ve been spitting them out.
Among U.S.-listed yieldcos, as of mid-March all but two were down at least 30% from their 52-week highs registered last spring (the two best performers had low double-digit losses). TerraForm Power Inc. and TerraForm Global Inc. both were off more than 75%.
In the case of the two TerraForms, they and their parent company, SunEdison Inc., have been clobbered by the latter’s financial problems and questions about its relationship with its two subsidiaries, which have cast doubt on the sustainability of its yieldco structure.
The Bullish Case
These missteps fuel the fire of critics who contend the yieldco structure is flawed. For others who believe in yieldcos, the early stumbles of a nascent industry create a buying opportunity.
“Absolutely this is a good time [to buy yieldcos],” says Tom Konrad, a certified financial analyst who manages portfolios for individuals and institutions focused on renewable energy and energy efficiency themes. “I don’t think we’ll see as good an opportunity again to buy yieldcos just because it’s such a young space, and you don’t get mispricings like this very often.”
Konrad stresses that not all yieldcos are alike. While TerraForm Power and TerraForm Global, along with Abengoa Yield Plc, have been negatively impacted by the financial problems of their parent companies, he notes that NextEra Partners has a strong sponsor, while other yieldcos such as Brookfield Renewable Energy Partners and Hannon Armstrong Sustainable Infrastructure develop projects internally. Another yieldco, Pattern Energy Group, has a private sponsor with protections in place to avoid conflicts of interest with it.
For income stocks such as these, Konrad uses the dividend discount model to estimate future dividends and chooses a required rate of return, or discount rate, which he says should be higher for riskier yieldcos. Based on his calculations, he says most yieldcos are trading below their inherent net worth.
For investors who don’t feel comfortable analyzing the merits or demerits of individual yieldcos but who still want to participate in the sector, the Global X YieldCo Index ETF is the lone fund focused on this space. This exchange-traded fund tracks the Indxx Global YieldCo Index consisting of 20 companies, and its recent SEC 30-day yield was 6.63%.
The product debuted last May, or just when the yieldco space in general was starting the head south. The fund has mirrored that trend, and as of mid-March was down about 30% since inception.
But Global X research director Jay Jacobs remains bullish on yieldcos for several reasons. For starters, he says there’s lots of expected growth in wind and solar power over the next five to 15 years, and Congress’s recent renewal of tax credits for solar and wind companies should encourage more investments in those areas. In addition, there’s a growing global commitment to renewable energy and climate change. And continuing falling costs in both wind and solar should continue for the next decade or so.